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August 21, 2016 at 12:49 pm
In forward rate agreements, would we not pay a premium to the bank like in the case of interest rate guarantee ?
And then what is the difference between both of the hedging options?
Please let me know.
August 21, 2016 at 4:05 pm
A premium is paid to the bank only when you opt for an option. With FRA, the borrower and bank agrees on a fixed interest rate and do not have the option to exercise (when interest rate is unfavourable)or allow it to lapse (when interest rate is favourable).
You only receive a compensation from the bank when the prevailing (transaction date) interest rate increase above agreed (fixed) interest rate. Conversely, you pay the bank a compensation when the prevailing interest rate is lower than the agreed interest rate.
With IRG, you have the flexibility to exercise or allow the option to elapse based on the change of the interest rate. Hence you are required to pay a premium to the bank.
In the nutshell, we would not pay a premium to the bank under FRA.
May 16, 2016 at 8:36 pm
the terms cap and floor seem redundant in the sense that when i buy a put option when i want to borrow, i am, by default putting a cap. and thus “traded caps” and “traded floors” are the same as traded options for put and traded options for calls respectively.
wd this be a correct way to summarize caps and floors?
John Moffat says
May 16, 2016 at 9:28 pm
December 1, 2015 at 3:19 pm
great lecture!!!! thank you sir!!!!!
December 1, 2015 at 4:30 pm
I am pleased you found it helpful 🙂
June 6, 2015 at 1:32 pm
I think this is linked to the wrong lecture (the previous interest rate risk one is playing again). It’s the same for both my android tablet and iphone. Thanks.
June 6, 2015 at 4:42 pm
thanks. it should be oK now.
May 19, 2015 at 1:39 pm
Good job…so simply and straightly put forth
March 18, 2015 at 11:46 am
good lecture lookign forward to the tricky part
October 10, 2014 at 2:42 am
Could you please explain the following terminologies in FRAs:
1. Trade date/ dealt date
2. Spot date
3. Fixing date
Thank you in advance.
October 10, 2014 at 12:25 pm
The trade date is the date we arrange the FRA. The spot date is when the arranging is finalised (usually 2 days after the trade date, but this is not a fixed rule). The fixing date is usually 2 days before the settlement date ( the date the loan starts) and is the day when the payment to be transferred if fixed.
I would be very surprised if you were tested on these terms in P4 – it is not that sort of exam.
August 19, 2013 at 9:06 am
October 21, 2012 at 8:39 am
In the FRA agreement example the difference is setteled with the bank at the start of the loan and interest would be payble at the end.
For loans with longer time periods the difference in timing might have a significant effect, would we have to take into account this when calculating the effective interest? Or is it unlikely to be asked of us in the exam?
October 21, 2012 at 6:51 pm
@htung00, That is usually the case (settle at the beginning and interest at the end) but it really depends on the agreement with the bank. It is unlikely to be relevant in the exam (it never has been!) but it would be good to mention it if you get the chance.
February 22, 2012 at 11:50 am
Sir, pls can u explain why we didnot calculate IRG for the interest rate of 8%.
May 2, 2012 at 8:33 pm
@sheda100, You can have the answer in the video lecture.
May 29, 2013 at 5:48 pm
since IRG is an arrangement with the bank whereby the bank fix a maximum interest rate, therefore the company could enjoy the actual low interest payment but with a premium payment indeed all time, like a option scheme.
May 29, 2013 at 7:24 pm
Yes – it is just like an option.
if the int rate falls the IRG is irrelevant – actually a benefit to you as you would pay less, only pay the actual interest and the premium charge
October 28, 2011 at 9:12 am
Sir, you have told that you will tell the reason why to divide always by 400 when calculating premium. Can you please explain why to do so ?
December 2, 2011 at 7:43 am
@Saline, It is explained in the next lecture i believe. ” intrest rate futures 1 “
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